Interest rates on hold

Chris Zappone

Update Home owners have been spared another rise in mortgage repayments, with the Reserve Bank opting to keep interest rates on hold while it weighs up the economic impact of the floods in Queensland and other parts of the country.

At its first meeting for 2011, the RBA kept the official cash rate at 4.75 per cent. Rates rose by a quarter of a percentage point four times last year, with the last rise in November.

Today's decision to stay put was in line with the expectations of economists and the credit market. The latter is pricing in less than one quarter-percentage point rise this year. (Read Malcolm Maiden's commentary here.)

"There's definitely no urgency to act in the near term, given the [flood] disruption to activity we've seen," said Mr Dinte, adding that Macquarie expected just one interest rate rise in 2011, which is likely to come in the middle of the year.

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The commercial banks, however, could raise interest rates outside the RBA cycle - a move that has sparked consumer and political fury in the past.

The strength of the overall economy remains patchy, with last year's interest rate rises restraining consumer spending and a stronger Australian dollar denting local industrial output. On the other hand, rising commodity prices and a bulging pipeline of projects will deliver a surge in activity in mining states - at least in regions not affected by the massive flooding of recent weeks.

The financial impact of the floods is still mounting but economists expect a short-term spike in prices, particularly for fruit and vegetables. While the economy in Queensland and other flood-affected regions may be disrupted in the short term, business activity is likely to rebound as the rebuilding efforts begin, they say.

The RBA governor Glenn Stevens said today the central bank would "look through" what it sees as "a temporary adverse effect on economic activity and prices" resulting from the floods.

"The bank's preliminary assessment is that the net additional demand from rebuilding is unlikely to have a major impact on the medium-term outlook for inflation," Mr Stevens said in a statement accompanying today's rates decision.

"We were a little surprised that they seem to think the rebuild from the Queensland floods is going to have very limited impact on growth and inflation in the medium term," said David de Garis, senior economist with NAB.

"We would argue potentially it would add greater pressure to resources in the labour market and be a bit more of an upside risk," he said.

One recruiter is also tipping an increase in employment as rebuilding starts in many regions.

"Recruitment remains steady in our sectors, although a number of companies have put on hold some roles due to the floods," said Rob Wallace, managing director of Victoria-based WHR Solutions. "They do expect that they will be needed down the track and from a business perspective, construction and mining are expecting a rejuvenation once the flood waters subside."

China boom

Mr Stevens said Australia continued to benefit from high commodity prices, noting the "very strong expansions" in key trading partners China and India. China, the world's second-largest economy, expanded 10.3 per cent in 2010, although recent data suggest some slowing of growth as the government attempts to rein-in inflation.

"Australia's terms of trade are at their highest level since the early 1950s and national income is growing strongly," Mr Stevens said. The terms of trade gauge the relative prices of Australia's exports versus the price of imports.

An RBA index of commodity prices released late today showed a rise of 4.5 per cent in January, building on December's 4.3 per cent increase, with the gains led by thermal and coking coal and iron ore. In Australian dollar terms, the gauge is up 35 per cent in the past year.

While the latest inflation figures were "consistent" with the RBA's medium-term goals, the bank expects some pick-up in wages the economy continues to grow.

"Employment growth was unusually strong in 2010. Most leading indicators suggest further growth, though most likely at a slower pace," Mr Stevens said. "

"After the significant decline in 2009, growth in wages picked up somewhat last year. Some further increase is likely over the coming year," he added.

Figures out last week for the December quarter showed underlying inflation at 2.25 per cent, its lowest rate in a decade and well within the bank's preferred 2 to 3 per cent target range.

The Australian dollar's rise has helped keep a lid on many prices. The currency has gained about 13 per cent over the past half year against the US dollar, making it the best performing among 17 major currencies tracked by Bloomberg.

Cautionary take

Some economists interpreted the overall tone of Mr Stevens's comments to suggest the RBA may be less likely to raise rates soon.

"The central bank has turned a little more cautious and is comfortable that previous monetary tightening has kept inflation, house price appreciation and credit growth in check," said analyst Matthew Circosta at Moody's Economy.com.

Mr Stevens said rising commodity prices had sparked a rise in private investment but noted that key other sections of the economy remained subdued. In the household sector "there continues to be caution in spending and borrowing, and an increase in the saving rate", he said.